The Law of Central Bank Reserve Creation
| Published date | 01 March 2022 |
| Author | Will Bateman,Jason Allen |
| Date | 01 March 2022 |
| DOI | http://doi.org/10.1111/1468-2230.12688 |
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Modern Law Review
DOI:10.1111/1468-2230.12688
The Law of Central Bank Reserve Creation
Will Bateman∗and Jason Allen†
This article explores legal and constitutional dimensions of central banks’ powers to create
money, ‘central bank reserves’, through monetary policy operations. Despite the prominence
of monetary authority since the Financial Crisis, the law supporting the creation of central bank
reserves is very obscure,as is the role of law in structuring constitutional authority over money.
We de-mystify those important matter s in three steps. Fir st, we explain, for a legal audience, the
role of central bank reserves in the nancial system and broader economy. Secondly,we anal-
yse the legal basis for the creation of central bank reserves in three prominent ‘North Atlantic’
monetary jur isdictions: the US Dollar, Euro and Sterling systems. Thirdly, we show how the
legal structure of central banking intermediates the constitutional state’s authority over money
through parts of the nancial system, focusing on high-prole policy proposals, including ‘QE
for the people’, and the creation of central bank digital currencies.
The monetary world is often divided into three types: currency (notes and
coins); central bank money (or central bank reserves); and private credit money
(deposits or loans).1Within that division, central banks have sole legal authority
to create bank notes and central bank reserves, and they guide the creation of
private credit money by commercial banks.For the last decade,monetar y policy
has been dened by outright asset purchases funded by central bank money,
leading to the creation of vastly more reserves than notes and coins, in the
Dollar, Euro and Sterling monetary systems.2
Despite their recent celebrity, central bank reserves appear to be legal
orphans, at least when compared to cur rency and private credit money.
∗Associate Professor, Law School, Australian National University. This article was prepared as part
of the ‘Legal and Economic Conceptions of Money’ project under the auspices of the ‘Rebuild-
ing Macroeconomics’ research initiative of the Economic and Social Research Council (ESCR)
and the National Institute of Economic and Social Research (NIESR). The authors wish to thank
the ESCR/NIESR and acknowledge the support, inspiration and insights of the other members of
that project team: Professor Rosa Lastra, Simon Gleeson,Dr Michael Kumho and Professor Saule
Omarova.This article was inspired by seminars given by the authors to the Federal Reserve Bank of
New York and the Bank of England in January 2020, and the authors greatly appreciated the pene-
trating questions asked by sta at both institutions.Finally, the authors are immensely grateful for the
insightful comments provided by the anonymous MLR reviewers which signicantly improved the
article. Except where otherwise stated,all URLs were last visited 23 August 2021.
†Senior Research Fellow, Humboldt-Universität zu Berlin.
1 See for example M. McLeay, W. Radia and R. Thomas, ‘Money Creation in the Modern Econ-
omy’ Bank of England Quarterly Bulletin No 1/2014 (14 March 2014).
2 Central banks throughout the world havealso adopted similar asset purchasing policies as emer-
gency responses to the Covid19 pandemic: P.Cavallino and F. De Fiore, ‘Central banks’ response
to Covid-19 in advanced economies’Bank of International Settlements Bulletin, No 21 (5 June
2020).
© 2021 The Authors. The Modern Law Review© 2021 The Moder n Law ReviewLimited. (2022) 85(2) MLR 401–434
The Law of Central Bank Reserve Creation
Legislation governing currency follows patterns familiar to lawyers and accessi-
ble by the citizenry. Statutory power is conferred on public institutions to issue
notes or mint coins, and that physical currency is designated as legal tender: the
state-sanctioned medium of exchange.3Legal power to create private credit
money is partly governed by the gargantuan statutes that regulate banks, via
statutory permissions to take deposits and issue credit, and partly governed by
the general law of contract, debt and property.4
Central bank reserves have no obvious legal parentage. No US, UK or Eu-
rosystem statute explicitly confers power on the FederalReser ve Banks (FRBs),
Bank of England, European Central Bank (ECB) or the National Central Banks
of the Eurosystem (NCBs) to create or retire reserves. On the contrary,in each
of those monetary systems the only explicit legal authority to create reserves lies
in general law powers of commercial banks to deposit (whether mandatorily
or voluntarily)5funds into accounts held at the central bank. For this reason,
the source of central banks’ power to create reserves is highly obscure.6This is
an unsatisfactory position given the vital importance of central bank reserves
to monetary policy,7economic policy,8political debate9and nancial entities’
earnings.10
To shed some light in dark corners, our core inquiries and claims in this
article are threefold. First, we explain the centrality of central bank reserves to
modern central banking and the broader economic system for a legal audi-
ence. That explanation covers the role of reserves in the payments system, the
settlement of inter-bank debts and the execution of monetary policy. The latter
topic is particularly salient, given the prominence of ‘unconventional’monetary
3 For Sterling-denominated bank notes and coins, see Currency and Bank Notes Act 1954 (2 &
3 Eliz II, c 12), ss 1 and 3; Coinage Act 1971 (UK), ss 3 and 4; for US Dollar-denominated
currency,see Federal Reserve Act 1913 (US), s 16(1) (12 USC §411); 31 USC §5112; for Euro-
denominated cur rency,see Treaty on the Functioning of the European Union,Ar t 128; Protocol
(No 4) on the Statute of the European System of Central Banks and of the European Central
Bank (ECB Statute), Art 16.
4 For US federal banking legislation, see 12 USC chapter 2; for the UK, see Financial Services
and Markets Act 2000 (UK), ch 3;for the general law which applies to the creation of deposits
by commercial banks, see R. Cranston et al, Principles of Banking Law (Oxford: OUP, 2018) 160;
Bank of Marin vEngland 385 US 99, 101 (1966);Citizens Bank of Maryland vStumf 516 US 16,
21 (1995); Foley vHill (1848) 2 HLC 28 [9 ER 1002].
5 As we explain below,the US and EU have mandatory ‘reserve requirements’,while the UK does
not: see text accompanying n 55 below and following.
6 The major anglophone texts on monetary law only touch briey on central bank reserves: S.
Gleeson, The Legal Concept of Money (Oxford: OUP, 2018) 4.41, 6,10-6,12, 6.58; C. Proctor,
Mann on the Legal Aspect of Money (Oxford:OUP,7
th ed, 2012,) 2.75-2.76, 33.57.
7 U.Bindseil, Monetary Policy Operations and the Financial System (Cambridge: Cambridge Univer-
sity Press, 2014) ch 2; Bank of England, ‘Liquidity Insurance at the Bank of England’ Media Re-
lease,October 2013 at https://www.bankofengland.co.uk/-/media/boe/les/markets/sterling-
monetary-framework/liquidity-insurance-at- the-boe.pdf .
8 W. Buiter ‘The Simple Analytics of Helicopter Money: Why It Works – Always’ (2014) 8 Eco-
nomics: The Open-Access, Open-Assessment E-Jour nal 1.
9 A. Jackson and B.Dyson, Modernising Money: Why Our Monetary System Is Broken and How It Can
Be Fixed (London: Positive Money, 2012).
10 M. Demertzis and G.B.Wol, ‘What Impact Does the ECB’s Quantitative Easing Policy Have
on Bank Protability?’Policy Contribution No 20 (Brussels: Bruegel,2016); J.Montecino and G.
Epstein,‘Have Large Scale Asset Purchases Increased Bank Prots?’ Institute for New Economic
Thinking Working Paper No 5 (March 2015).
402 © 2021 The Authors. The Modern Law Review© 2021 The Moder n Law ReviewLimited.
(2022) 85(2) MLR 401–434
Will Bateman and Jason Allen
policy over the past decade in the form of ‘quantitative easing’(QE) operations.
While some of those details will be familiar to nancial-market participants,
they are less well known by legal scholars, despite being critical preconditions
to understanding the signicance of the legal frameworks governing the cre-
ation of central bank reserves and the nature of constitutional authority over
money.
Secondly, we ask ‘what legal authority supports the creation of central bank
reserves?’ Our answer, ‘it depends’, reects the organisational complexity of
modern central banking. Two distinct pathways lead to the creation of central
bank reserves.First, commercial banks create central bank reserves by exercising
general legal powers to lend money to central banks by making deposits into
reserve accounts. Secondly, central banks create reserves as a consequence of
exercising statutory powers to ‘purchase’, ‘sell’, ‘buy’ or ‘deal in’ securities with,
or ‘lend’ to, nancial market counterparties. In both cases, legal rules relating to
settlement nality shore up the function of central bank reserves as an apex set-
tlement asset in the relevant monetary system.This being the case, we argue that
central banks’ legal authority to create reserves is best characterised as implied or
incidental to central banks’ express powers to transact in nancial markets. We
explain why those two regimes co-exist, and note some complexities of that
co-existence, including accounting for reserves as liabilities and paying interest
on excess reserves, despite the fact that the overwhelming majority of reserves
are monetary units made by central banks, rather than deposits of commercial
banks.11
Thirdly (in conclusion), we ask ‘what impact does the legal basis of central
bank reserve creation have on the exercise of monetary authority:thepower of
states to create, retire and control the value of money?’ We answer that question
by explaining the role of law in intermediating monetary authority through the
private nancial system: legal institutions presently cabin basic authority over
money by reference to various xed features of nancial markets:willing coun-
terparties, marketable nancial assets and consensual bargaining. We call this
‘intermediated monetary author ity’ and illustrate its basic features by reference
to central bank operations in response to emergencies: the nancial crisis and
the Covid-19 pandemic.We then explain the impact of that form of monetary
authority on several presently prominent topics in legal, nancial and political
engagements with central banks: (i) the relationship between central banks’ le-
gal capacities and their ‘mandates’; (ii) the notion that central banks are ‘magic
money trees’; and (iii) proposals for the issue of digital cur rencies by central
banks to non-nancial rms and the general public In that way, our descriptive
legal analysis of central banks is linked to foundational issues in the design of
constitutional institutions and major public policy choices confronting national
governments, central banks and each populace to which they are ultimately
accountable.
Our close analysis of the law of central bank reserve creation is under-
taken in light of the increased public awareness of central bank operations since
the adoption of unconventional monetary policy techniques, particularly QE.
11 See D.Archer and P.Moser-Boehm, ‘Central Bank Finances’ BIS Papers No 71 (April 2013).
© 2021 The Authors. The Modern Law Review© 2021 The Moder n Law ReviewLimited.
(2022) 85(2) MLR 401–434 403
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